There are a number of lessons to be learned from Tibble v. Edison International, a case focused largely on the investment fees incurred by Southern California Edison’s 401(k) Savings Plan (the Plan). One of those lessons involves issues that fiduciaries should think about, plan for and deal with in connection with revenue-sharing payments.
The term “revenue sharing” in the retirement plan industry refers generally to payments made by investment providers, such as mutual fund companies and insurance companies, to other service providers, such as recordkeepers and third-party administrators. These payments include so-called 12b-1 fees and sub-transfer agent fees. At least in some instances, these payments are made in exchange for services that the party making the payment (e.g., the mutual fund company) would otherwise have to provide itself, such as administrative services.
There is nothing inherently contrary to law about revenue sharing payments. The recognition that these payments are not inherently contrary to law is that the Department of Labor has issued a proposed regulation that, upon its effective date, will require service providers to disclose indirect compensation (such as revenue sharing payments) to service providers. The reason for the regulation is not the inherent illegality of revenue sharing, but rather a recognition that the law currently may not require disclosure of that information. What ERISA does require is that plan fiduciaries be aware of the services being provided in return for the compensation that the fiduciaries are paying. Regardless of whether revenue sharing has been affirmatively disclosed, fiduciaries need to know who is performing what service in order to evaluate the reasonableness of the compensation.
The Facts in Tibble Relating To Revenue Sharing
In Tibble, the Plan document in effect for much of the relevant time period provided that Southern California Edison (SCE) — and not the Plan itself — would be responsible for the cost of Plan administration. Eventually, the Plan was amended to state that: “The cost of the administration of the Plan, net of any adjustments by service providers, will be paid by SCE.”
SCE’s Board of Directors had delegated to its Trust Investment Committee and/or its Benefits Committee the fiduciary obligation to select and monitor the Plan’s investment options. Members of these committees were not simultaneously members of SCE’s Board of Directors — a fact which turned out to be critical to the court’s decision.
The Plan’s recordkeeper, Hewitt Associates, LLC (Hewitt), received certain revenue sharing payments from some of the mutual funds offered by the Plan. To the extent Hewitt received revenue sharing payments, Hewitt reduced its administrative fees to SCE. Therefore, SCE received a benefit — in the form of reduced administrative expenses — as a result of the revenue sharing payments that Hewitt received from mutual funds offered as Plan investments.
Plaintiff ’s Claim Related to Revenue Sharing, the Court’s Holding, and The Current Status of Tibble:
ERISA §406(b)(3) prohibits a fiduciary from receiving consideration “for his own personal account from any party dealing with such plan in connection with a transaction involving the assets of the plan.” Plaintiffs claimed that SCE engaged in just such a prohibited transaction because the fees it owed to Hewitt were reduced as a result of these revenue sharing payments.
In other words, according to the plaintiffs, SCE “received consideration” from Hewitt in connection with a transaction involving the Plan assets.
The court disagreed. It held that the party that received the benefit of the transaction (SCE) was not the party that selected the mutual funds that generated the revenue sharing payments. Rather, SCE had delegated to certain committees the fiduciary obligation to select specific investment options, and none of the members of those committees were simultaneously members of SCE’s board of directors. Also, there was no evidence that SCE itself influenced whether to enter into the contracts with the mutual funds. Therefore, SCE could not violate §406(b)(3).
As indicated above, the decision in Tibble is currently on appeal to the U.S. Court of Appeals for the Ninth Circuit. On May 25, 2011, the Secretary of Labor filed an amicus curiae (“friend of the court”) brief. Not surprisingly, the Secretary’s brief disagreed with the district court’s holding on the revenue sharing issues. The Secretary argued that the district court erred in relying on certain Department of Labor advisory opinions when the district court ruled that SCE did not engage in a prohibited transaction. According to the Secretary, those advisory opinions do stand for the proposition that a fiduciary does not engage in prohibited transactions by receiving fees for its services, provided that the fiduciary does not set its own compensation. However, the Secretary argued that those advisory opinions do not support a conclusion that the committees that made the investment decisions in Tibble were sufficiently independent of the company to apply the rule discussed in the advisory opinions.
On August 1, 2011, the California Employment Law Council and the Investment Company Institute both filed amicus briefs supporting the district court’s decision. These briefs focused largely on separate aspects of the Tibble case — namely, whether defendants breached their fiduciary duties by offering certain “retail” mutual funds as plan investment options, when, according to the plaintiffs, lower-cost “institutional” share classes were available, and whether the district court erred in holding that plaintiffs’ challenges to funds added to the Edison plan more than six years before the lawsuit was filed were barred by the applicable statute of limitations. Neither directly addressed the substance of the revenue sharing issue.
In their own brief, the defendants focused on the district court’s factual finding that the plaintiffs failed to “demonstrate that the Plan fiduciaries were motivated by revenue sharing when selecting mutual funds for the Plan.” In part, the district court based its finding on the fact that in the vast majority of changes to the investments, the changes resulted either in a reduction in revenue sharing, or no net change in the amount of revenue sharing received by SCE: “The Plan fiduciaries did not make fund selections with an eye toward increasing revenue sharing and did not put the interests of [SCE] above those of the Plan participants.”
Lessons to be Learned, Regardless of the Outcome of the Appeal:
According to the terms of the Plan, the plan sponsor (SCE) was responsible for payment of the Plan’s administrative expenses. If the Plan had provided that the administrative expenses would be paid from plan assets, then the plan would have received the benefit of the cost reductions brought about by the revenue sharing. The willingness of the plan sponsor to state in the plan that it was responsible for paying plan expenses emphasizes the old adage that no good deed goes unpunished. Tibble should be required reading for those who draft retirement plans. The apparently generous decision of SCE to shoulder the burden of paying the administrative expenses of the Plan did not lead to ERISA liability, because the members of the plan committees that selected the investments were not also on the plan sponsor’s board of directors. Plan sponsors would be well to consider the decision to pay plan expenses given the kinds of arguments plaintiff and DOL made in Tibble.